1. Field of the Inventions
The field of the invention relates generally to electronic securities trading and more particularly to an electronic securities trading system that includes automated issuance and conversion of Depositary Receipts.
2. Background Information
The desire of individual and institutional investors to diversify their portfolios, reduce risk, and invest internationally in the most efficient manner possible has driven the demand for Depositary Receipts (DRs), which include American DRs (ADRs), Global DRs (GDRs), European DRs (Euro DRs), and New York Shares (NYSs). When registered in the U.S. DRs are negotiable U.S. securities that generally represent a non-U.S. company's publicly traded equity. Although typically denominated in U.S. dollars, DRs can also be denominated in other currencies. Further, DRs can be eligible to trade on all U.S. stock exchanges as well as on many other, non-U.S. stock exchanges.
While investors may recognize the benefits of global diversification, they also often understand the challenges presented when investing directly in local trading markets. These obstacles can include inefficient trade settlements, uncertain custody services, and costly currency conversions. DRs overcome many of these operational and custodial hurdles inherent in international investing. Moreover, cost benefits and conveniences may be realized through DR investing, thus allowing those who invest internationally to achieve the benefits of global diversification without the added expense and complexities of investing directly in the local trading markets.
DRs are issued when a broker purchases a non-U.S. company's shares on a local stock market, i.e., in the home country of the non-U.S. company, and delivers those shares to the depositary's local custodian bank, which then instructs a depositary bank to issue DRs. In addition, DRs can also be purchased in the U.S. secondary trading market. Just like any other U.S. security, DRs can be freely traded, either on an exchange or in the over-the-counter market, and can be used to raise capital.
DRs can be more specifically referred to as ADRs, Rule 144A DRs, or GDRs. These names typically identify the market in which the DRs are available: ADRs are publicly available to U.S. investors on a national stock exchange or in the over-the-counter market; Rule 144A ADRs are privately placed and resold only to Qualified Institutional Buyers (QIBs) in the U.S. QIB PORTAL market; and GDRs are generally available in one or more markets outside the foreign company's home country, although these may also be known as ADRs.
Currently, there are over 2,000 ADR programs for companies from over 70 countries. The establishment of a DR program, and in particular an ADR program, offers numerous advantages to non-U.S. companies. The primary reasons to establish a DR program can be divided into two broad considerations: capital and commercial. Some specific advantages of DRs for a foreign company include: expanded market share through broadened and more diversified investor exposure with potentially greater liquidity, which may increase or stabilize the share price; enhanced visibility and image for the company's products, services and financial instruments in a marketplace outside its home country; flexible mechanism for raising capital and a vehicle or currency for mergers and acquisitions; and DRs enable employees of U.S. subsidiaries of non-U.S. companies to invest more easily in the parent company.
When investors aim to diversify their portfolios internationally, obstacles such as undependable settlements, costly currency conversions, unreliable custody services, poor information flow, unfamiliar market practices, confusing tax conventions, and internal investment policy can discourage institutions and private investors from venturing outside their own local market. DRs, e.g., ADRs, can help to address some or all of these problems. Some specific examples of the advantages of DRs to investors include: quotation in U.S. dollars and payment of dividends or interest in U.S. dollars; diversification without many of the obstacles an investor or other institutions may have in purchasing and holding securities outside of their home market; elimination of global custodian safekeeping charges; familiar trade, clearance and settlement procedures; competitive U.S. dollar/foreign exchange rate conversions for dividends and other cash distributions; and the ability to acquire the underlying securities directly upon cancellation.
DRs are issued or created when investors decide to invest in a non-U.S. company and contact their brokers to make a purchase. These brokers, through their international offices or through a local broker in the company's local market, purchase the underlying ordinary shares and request that the shares be delivered to the depositary bank's custodian in the foreign country. The broker who initiated the transaction will convert the U.S. dollars received from the investor into the corresponding foreign currency and pay the local broker for the shares purchased. On the same day that the shares are delivered to the custodian bank, the custodian notifies the depositary bank. Upon such notification, DRs are issued and delivered to the initiating broker, who then delivers the DRs evidencing the shares to the investor. A broker can also obtain DRs by purchasing existing DRs in the U.S. secondary market, which is not a new issuance.
Generally, when a DR holder sells, the DRs can either be sold to another U.S. investor or it can be canceled and the underlying shares can be sold to a non-U.S. investor. When investors want to sell their DRs, they notify their broker. The broker can either sell the DRs in the U.S. market through a secondary market trading transaction or sell the shares outside of the U.S., typically into the local market through a cross-border transaction. In cross-border transactions, brokers, either through their international offices or through a local broker in the company's local market, will sell the shares back into the home market. In order to settle the trade, the U.S. broker will surrender the DRs to the depositary bank with instructions to deliver the shares to the buyer in the local market. The depositary bank will cancel the DRs and instruct the custodian to release the underlying shares and deliver them to the local broker who purchased the shares. The broker will arrange for the foreign currency to be converted into U.S. dollars for payment to the DR holder.
In intra-market transactions, DRs can be sold to subsequent U.S. investors by simply transferring them from the existing DR holder (seller) to another DR holder (buyer). An intra-market transaction is settled in the same manner as any other U.S. security purchase, i.e., in U.S. dollars on the third business day after the trade date and typically through the Depository Trust Company (DTC). Intra-market trading accounts for the vast majority of all DR trading in the market today.
Once there are an adequate number of DRs outstanding in the U.S. market, e.g., when 3-6 percent of a company's shares are in DR form, a true intra-market trading market emerges. Until this market develops, the majority of DR purchases result in DRs being issued upon the deposit of shares. When executing a DR trade, brokers seek to obtain the best price by comparing the DR price in U.S. dollars to the dollar equivalent price of the actual shares in the local market. Brokers will buy or sell in the market that offers them the best execution price and they can do so in three ways: by issuing a new DR, canceling a DR, or U.S. secondary market trading. For example, if the price of the actual shares in the local market is $12.28 per share after allowing for foreign currency translation, and the DR is selling for $12.30, the broker will buy shares and issue DRs until the price of the ordinary shares increases to $12.30, at which time the broker will simply buy and sell the existing DRs that are outstanding in the market. The broker may also be holding an inventory of ordinary shares, in which case the local trading price is irrelevant. The continuous buying and selling of DRs in either market tends to keep the price differential between the local and U.S. markets to a minimum.
When a non-U.S. company completes an offering of new shares, part of which will be sold as DRs, e.g., ADRs, in the U.S. or international market, the company will deliver the shares to the depositary bank's local custodian at the time of the closing. The depositary bank will then issue the corresponding DRs and deliver them to the members of the underwriting syndicate. With this pool of DRs, a regular trading market can commence where DRs can be issued, canceled, or traded in the U.S. secondary market.
Thus, DRs can be used to facilitate cross-border trading and to raise capital in global equity offerings or for mergers and acquisitions to U.S. and non-U.S. investors. Over the last ten years demand by investors for DRs has grown significantly. As mentioned, this growth is driven in large part by the increasing desire of retail and institutional investors to diversify their portfolios globally. Many of these investors typically do not, or cannot for various reasons, invest directly outside of the U.S. and, as a result, use DRs as a means to diversify their portfolios. Many investors who do have the capabilities to invest outside the U.S. may still prefer to use DRs because of the convenience, enhanced liquidity, and cost effectiveness DRs offer as compared to purchasing and safekeeping ordinary shares in the home country. In many cases, a DR investment can save an investor up to 10-40 basis points annually as compared to all of the costs associated with trading and holding ordinary shares outside the United States.
A limitation of conventional DR trading systems and methods is that there is presently no ability for an investor to directly and electronically access a local trading market and electronically settle the trade in the U.S. through DRs and in U.S. dollars. This is because global electronic trading is a recent development as is direct, electronic foreign exchange trading. Further, DR conversion is presently a manual process in conventional systems. Another limitation is that for many investors, the conversion process, i.e., the factors that effect the ultimate cost of conversion, is not always transparent to the investor.